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Kudlow Says the Party's Just Getting Started, but Is the Economy Headed for a Hangover?

Leah Millis

By Michael Rainey

October 12, 2018

MOST POPULAR

Senior White economic advisor Larry Kudlow touted the Trump economy Friday, telling CNBC that “[w]e're in a hot economic boom. There's no end in sight." As a result, the stock market should “get back on track” soon following the recent swoon.

Some critics on social media immediately questioned Kudlow’s track record – Kudlow famously said, just as the Great Recession was beginning in December 2007, that the “Bush boom” would continue “for years to come.” But a new report from Ethan S. Harris, global economist at Bank of America Merrill Lynch, provides a more nuanced critique of Kudlow’s emphatically optimistic view of the strength of the U.S. economy.

“The US economy is red hot,” Harris writes, with GDP growth expected to remain near 4 percent in the third quarter. The “double dose” of fiscal stimulus set into motion in the past year – tax cuts and increased federal spending – gets much of the credit for the elevated growth, Harris says, but has also created the risk of a “boom-bust” scenario. Now, nearly a year into the new fiscal policies, the odds of that scenario are rising.

The main problem, as Harris and many other economists have noted, is that the fiscal boost was enacted in an economy that was already near full employment. This is creating demand pressures that already creating strains in the labor supply and in industrial capacity, Harris says. This tightening will force the Federal Reserve to continue raising interest rates as it steps in to “water down” the punchbowl. The only question is the timing of the Fed’s rate hikes.

At the same time, the tax cuts have done little to increase the economy’s long run growth potential, Harris says, and the rising interest rates produced by both the surge in government borrowing and by Fed policy should bring economic growth back down closer to its previous trajectory within the next year or two.

Asked about the disconnect between the White House’s rosy economic projection of 3 percent GDP growth for years to come and those of just about every other forecaster (see chart below), Kudlow reiterated his belief that the Trump economy is breaking the mold and that critics of the Trump economic program will be proven wrong.

“People have badmouthed it, said it can’t work. Lower tax rates won’t work. Deregulation won’t work. Unleashing energy won’t work. Telling the business community to take a good rip at the ball, bringing people back into the labor force. I like the skepticism. Okay? Me – I’m taking the over,” Kudlow said. “So far I think we’ve proved the skeptics to be quite wrong. I don’t think that will change.”